Boom Times

After its privatization in 1997 and the appointment of Roger Agnelli as its CEO in 2001, Brazilian mining company Vale has become the darling of Wall Street. Under Agnelli’s leadership, Vale has streamlined and focused business operations, making it the world’s largest iron ore exporter and second largest mining company. Meanwhile, Vale’s market capitalization grew from US$9 billion to US$100 billion. Industry observers believe Vale’s success is driven by booming domestic demand. With a population of 200 million, Brazil is a fast-growing nation with huge market potential. The country’s need to further develop its infrastructure will continue to fuel domestic demand for iron ores and other metals and minerals. To capitalize on these opportunities, Agnelli (known as the “Iron Man” for his nerves of steel and knack for negotiation), divested businesses that would distract it from its core competency, metal mining, especially in iron ore, copper and zinc. The divested businesses included paper and pulp, steel, and transportation. In addition to distracting management from Vale’s core operations, these businesses were heavy electricity users, making Vale heavily dependent on the whims of the Brazilian government, which controls electricity production. The strategic alignment to Vale’s core competencies eventually allowed Vale to control about 90% of Brazil’s iron ore production.

Boom Times

After its privatization in 1997 and the appointment of Roger Agnelli as its CEO in 2001, Brazilian mining company Vale has become the darling of Wall Street. Under Agnelli’s leadership, Vale has streamlined and focused business operations, making it the world’s largest iron ore exporter and second largest mining company. Meanwhile, Vale’s market capitalization grew from US$9 billion to US$100 billion. Industry observers believe Vale’s success is driven by booming domestic demand. With a population of 200 million, Brazil is a fast-growing nation with huge market potential. The country’s need to further develop its infrastructure will continue to fuel domestic demand for iron ores and other metals and minerals. To capitalize on these opportunities, Agnelli (known as the “Iron Man” for his nerves of steel and knack for negotiation), divested businesses that would distract it from its core competency, metal mining, especially in iron ore, copper and zinc. The divested businesses included paper and pulp, steel, and transportation. In addition to distracting management from Vale’s core operations, these businesses were heavy electricity users, making Vale heavily dependent on the whims of the Brazilian government, which controls electricity production. The strategic alignment to Vale’s core competencies eventually allowed Vale to control about 90% of Brazil’s iron ore production.

It would be a mistake, however, to attribute Vale’s successes solely to domestic conditions. During Agnelli’s era as CEO, he also altered Vale’s management system. He changed Vale’s culture to a meritocracy where healthy competition was encouraged between employees. This allowed the organization to attract and retain talented individuals not only domestically, but internationally.

These strategic changes coincided with the rise and economic development of China. As China’s economy boomed, the demand for metals and minerals rapidly increased in order to keep pace with the country’s infrastructure, specifically the growing construction and manufacturing industries. By 2010, China had become Vale’s biggest customer for iron ore – buying over 43% of Vale’s production.

China and Africa Opportunities

China is the largest iron ore importer in the world, accounting for 60% of global trade by volume. To meet soaring Chinese demand, Vale commissioned 35 very large ore carrier (VLOCs) or “Valemax” class vessels, to be built to transport ore. Entrance to this highly lucrative market, however is impeded by strong competitors, internationally and locally. It is further exacerbated by local competitors who lobbied the government to prevent large vessels, such as “Valemax,” from entering Chinese ports.

With vast mineral resources, Africa is key to Vale’s long term growth. From the copper belt in the Democratic Republic of Congo to the rich iron ore deposit in Guinea’s Simandou range, these regions represent Vale’s diversification initiatives, as well as its potential to become the world’s largest mining company. Success in Africa, however, is far from certain. Vale faces stiff competition from other SOEs including China’s Jinchuan. Crumbling infrastructure means significant investment in the region is needed to improve transportation, a key factor for the mining industry. Vale also faces the dilemma of the obsolescing bargain –as it provides capital and infrastructure, bargaining power will shift to benefit local ore producers.

SOE What?

Vale’s performance is even more remarkable in light of its roots as a state-owned enterprise (SOE). Although the Brazilian government quickly embraced privatization of key natural resources in order to save its economy in the 1990s, it maintained a keen interest on the development of these resources. The Brazilian government, through the Brazilian National Development Bank (BNDES) and its investment subsidiary (BNDESPar), started to slowly increase its shareholder stakes on these former state champions. Rather than having direct control over these companies, it chose minority ownership and exercised control indirectly. This approach has been replicated by other developing nations, such as China and Russia, as a way to control the growth of the nation. Through this approach, Vale became one of Brazil’s SOEs.

While corporate restructuring and divestment was a boon to Vale and its shareholders, it also came at a cost – layoffs and reduction of investments by US$5 billion in key industries critical to Brazil’s economy. Agnelli’s actions were frowned upon by a key minority shareholder, the Brazilian government. It wanted Vale to use its financial strength to invest and revive the Brazilian shipbuilding industry. Agnelli, who realized ships could be built more efficiently in China, ignored the request. Investment in shipbuilding would expose Vale to higher operational costs due to the associated high electricity and human capital costs. Agnelli’s insistence on economic return rather than economic nationalism was the basis for many of his disputes with the Brazilian government. This was also the cause of his eventual downfall in May 2011 when he was replaced by Murilo Pinto de Oliveira Ferreira at the behest of the Brazilian government.

New Era

Ferreira’s immediate task was to fill the giant void left by Agnelli. Ferreira also had to calm investors who felt that continued government interference could hinder Vale’s growth and profitability by blunting its competitive edge. The government, by playing the role of Vale’s safety net, unwittingly created a moral hazard within the organization. Ferreira’s other top priority was fulfilling the demands of his Brazilian supporters by investing in national projects to help Brazil’s economic development.

Vale and Brazil for the Future

For Vale to succeed under Ferreira’s leadership, he will have to perform a juggling act – balancing the interests of its corporate shareholders as well as the Brazilian government. While industry observers have long written about the disadvantages of the SOE approach and how it can result in inefficiency and slowing down of technological advancement, having the Brazilian government as a minority shareholder can provide Vale with certain opportunities. Ferreira’s first task is to make the case to the Brazilian government that Vale’s core competency is with iron ore and the development of transportation infrastructure. Investment within Brazil should be focused on initiatives that will allow Vale to efficiently transport minerals within Brazil. In addition, Vale should also leverage its role as an SOE to push for more favorable mining regulations, electricity rates, and labor laws from the Brazilian government. This will allow Vale to continue to maintain its competitive advantage while increasing shareholder value. Doing so, Ferreira will be able to fulfill Vale’s corporate responsibility, satisfy its shareholders and at the same time assist the Brazilian government in achieving its goal of further developing Brazil and its economy.

‘Kuai’ Pro Quo in China

Ferreira will need to dedicate and align sufficient company resources to better understand the intricacies of the Chinese market. These include rapid currency inflation of the Yuan, stiff competition and protectionist policies all which can impact Vale’s operations and penetration into China. Ferreira should leverage Vale’s role as an SOE and request that the Brazilian government communicate directly with its counterparts. Requesting that the Chinese open their borders to fair competition and allow “Valemax” to access shipping ports will be crucial in the company’s growth within the region. Success would allow Vale to gain parity with its Australian competitors, since the “Valemax” vessels will reduce shipment of iron ore from Brazil to China to an average of 45 days by gaining access to Chinese ports, increasing the companies shipping capacity and capabilities. Vale will able to hedge against the costs of shipping, allowing the company to maintain an effective operational costs as well as competitive pricing. This will allow Vale to maintain market share within China.

In return for the Brazilian government’s assistance with the Chinese government, Vale should develop strategic alliances with steelmaking companies such as Gerdal, CSN and USIMINAS. This will allow Brazil to quickly revive its steelmaking industry; a key industrial pillar identified by the Brazilian government to spur continued economic growth.

Dealing in Africa

In addition to being a major player in the Chinese market, Vale is in a race to gain access to Africa’s vast untapped natural resources. The presence of strong competition within the region, is a significant challenge for the mining company. The lack of infrastructure, obsolescing of bargaining and the instability of the region are major barriers to entry. Investments in Africa represent a major risk as well as a major opportunity. First movers that manage to gain access to a majority of these resources, will control the global mining industry for the foreseeable future.

Rather than going at it alone, Vale could significantly reduce its risks by creating a consortium with its competitors and by working with the World Bank to develop the region. The International Financial Corporation (IFC) and International Bank for Reconstruction and Development (IBRD), both a division of the World Bank can significantly reduce risks for Vale, while at the same time allowing them to develop the region’s infrastructure and effectively move the resources. The establishment of a consortium with potential UN involvement will also allow Vale to learn from its competitors, benchmark its operations and improve upon them to maintain competitive advantage.

Will Vale be successful?

Vale’s success in the future will be dependent on Ferreira’s ability to leverage Vale’s status as an SOE. While SOEs are commonly looked down upon by free market economists, there are examples to the contrary such as Singapore Airlines. SIA is an SOE that enjoys the highest ranking amongst all airlines worldwide. The Singapore government, through Temasek Holding, is a minority shareholder in the company. Singapore Airline’s skillful management of the demands of both its public and private shareholders and commitment to its customers allowed it to become the best airline in the industry. Vale would be wise to emulate Singapore Airline’s success by leveraging its status as a SOE to its advantage, while delivering value for all of its stakeholders. Only by embracing this duality will Vale be able to unlock its true potential.